After RIABiz broke the news that Schwab was introducing an index-based 401k, representatives at the company called to say they felt our story put too much emphasis on the ETF portion of the plan. They offered to allow Walt Bettinger, Schwab’s president and CEO, to respond to questions from RIABiz to flesh out the company’s strategy.

We were worried the responses would come back in corporate-speak. Not so. Schwab’s pr team says that Bettinger answered the questions below himself, some in written form and some to a note-taking staffer. In his final answer, he even alluded to Schwab studying a way to use RIAs as a means of going after the “large end of the 401(k) marketplace.” (See below.)

Currently, Schwab has 1.5 million corporate retirement plan participants. Schwab has about $233 billion in assets in its institutional business, which is mostly retirement plan assets but includes some other assets.

It’s too soon to know how the introduction of an indexing-only 401(k) plan from a top brand is going to change the landscape of the 401(k) arena, said Rick Meigs, chief executive officer of consulting firm 401khelpcenter.com LLC in Portland, Ore. But he predicts that if Schwab is successful other companies are going to join the bandwagon trying to introduce a similar-type of product.

“One thing is certain: all of Schwab’s competitors are going to be watching this closely,” he said. “They’re all going to be looking for signs that Schwab’s move is positive for Schwab. If Schwab picks up market share and increases business, then all of the vendors are going to start pushing product and introducing something similar.”

Though Bettinger downplays the centrality of ETFs to Schwab’s new 401(k) initiative, ETF use in 401(k)s is on the rapid rise right now, according to Sue Thompson, managing director at iShares, head of RIA sales for BlackRock of New York. She is based in Phoenix.

Only about 1% of flows into ETFs were the result of 401(k) investments in 2010. In January of 2011, they were 10%. “We’re already off to a run rate of 10 times (what it was in 2010)” she says. “It goes to the fact that we’ve gotten a lot more ETF-enabled platforms.”

Bettinger said Schwab is also working on a way for RIAs to deliver high-level advice to plan participants. Historically, it’s been difficult for companies to develop a profitable model to do so. “Many studies support the efficacy of providing high quality advice to plan participants. The problem is many participants are not desirable clients to most RIAs and this service model, while effective, is costly and time-consuming. If Schwab is able to do this it would be tremendous and could potentially revolutionize the 401k industry,” said Craig Watanabe, principal with Penniall & Associates Inc., an RIA in Pasadena, Calif. Penniall & Associates has about $600 million in 401(k) assets under management.

Schwab refused to provide more details on that aspect of its retirement strategy — but you’ll see what Bettinger did tell us at the end of this Q&A.

Q. What has Schwab’s 401(k) business been like historically and how do you envision things will change with the ETF-only 401(k)? What niche is Schwab strong in and how can you build on that?

A. Our 401(k) business has steadily grown over the years, and our approach has been consistent: We’ve always focused on how to best serve the participants. We’ve done this by being transparent around pricing, and ensuring that participant costs are as low as possible. We’ve been a leader in taking an open investment architecture approach that provides participants with choices. We were early providers of self-directed 401(k) accounts for those plan sponsors that felt it would be an appealing option for their employees.

Over the years, we’ve become very aware that the two most important elements for participant success are lower investment costs and customized, personalized participant advice. We think that combining the two is where we can have greatest impact.

Let’s cut through the noise that is out there. All things being equal, a participant spending a career in a program offering an index oriented line up of investments will end up retiring with $115,000 more in their account over a similar participant using actively managed funds.

And when it comes to advice – we know one thing for sure, it works. Employees who are currently taking our customized advice save at twice the rate, 10% of their pay vs. 5%. They are diversified across eight funds, while self-directed employees are in less than four. And over 90% of employees receiving our customized advice stayed in their asset allocation despite the market’s fall in early 2009 and have now benefitted from the almost doubling of the market in the past two years.

In many ways, this new initiative is an evolution of what we’ve done in the past and simply takes things one step further. This new option for plan sponsors focuses on low-cost indexed mutual funds or ETFs, combined with personalized professional advice. For many plan sponsors that is a very appealing combination – and it certainly fits with what we stand for as a company.

Q. The 401(k) business is crowded and competitive and has dominant brands like T. Rowe Price, Vanguard and Fidelity, which have tremendous economies of scale. How can Schwab make a dent in these franchises both in terms of price and advice delivered?

A. Our primary focus is not on our competitors, it is on how to serve participants in the way that maximizes their accumulation of money for retirement.

Of course, we are already right in the thick of the competitive pack with these firms now – and doing well when we compete head to head with them. With our brand and our focus on how to make the results even better for the participant, through lower investment cost and customized advice, we think we have an opportunity to dramatically change the competitive landscape. We think we’re heading in exactly the right direction, for the long-term. Other firms could follow suit, but with an entrenched legacy business built on higher-cost actively managed funds, I expect they may not want to – at least until employers push them to follow.

Moving down a path of an indexed approach coupled with customized advice is the right action at this time, and I am confident that this new approach will appeal to many employers. That said, we are the first ones to say that this new approach will play out over several years.

Q. How do you address advisors’ concerns that there’s not an appetite for ETFs in the 401(k) arena? What types of educational efforts are you involved with to ensure that investors understand ETFs.

A. We are disappointed, yet not surprised that some pundits are overly focused on the ETF aspect of what we are planning. We are focused on two things – lowering the fees that employees pay for their investments, and offering customized advice.

ETF’s are simply one option we will make available to employers to help lower the investment costs for participants. If an employer has hesitation about offering ETF’s to their employees, we will also offer a 401k offering that exclusively uses index mutual funds. That is called choice.

For employers who decide to go with the ETF version of our offering, we will provide ETF education. However, customized employee advice is far more important than education.

Q. Some advisors are concerned that employers won’t want their employees making trades in their 401(k) plan throughout the day. How will you address those concerns? Will you allow employers to include provisions in the plan document that would limit the number of trades?

A. That sounds like the same questions people asked 25 years ago when the 401k industry moved from quarterly processing of account values to daily valuation updates. Those who had a vested interest in the old approach argued that employees would trade their mutual funds every day. It was a bit of a silly attempt to deflect from the benefits then, and it is the same silly attempt now to argue against the low cost and transparency offered by ETF’s.

We custody over $100 billion in ETF’s today and the population of people who trade them with any frequency is extraordinarily tiny. That said, if there are concerns, we will offer employers the ability to limit the level of trading. And because customized advice is a key component of the strategy, we believe that will further limit actively trading in accounts. Participants that use managed solutions wouldn’t be trading at all.

The key benefit we are providing with both indexed mutual funds and indexed ETFs is an incredibly efficient and low cost means of constructing well-diversified long-term portfolios. That is the appeal to employers, and we believe it will ultimately be the appeal to participants.

Q. What types of employers are you hoping to get to sign up for the ETF-only 401(k) – larger companies or smaller-niche corporations? Do you have any commitments yet? Are you mostly targeting white-collar workers or do you envision this working in a blue-collar environment?

A. Historically, we have been a strong competitor in the mid to large size plan area and we expect that pattern will continue with the introduction of these new options.Low investment costs and customized, personalized professional advice are appealing regardless of the color of your collar. Yes, it’s early, but we want to get started and get out in front of what will certainly be a long term transformation of the industry.

Q. Considering the costs of trading ETFs, can you keep this economical?

As the leading custodian of ETF assets, we have tremendous scale. For employers who opt forthe ETF approach, it will lower investment costs for participants by 35 to 85%. I think that is the definition of economical.

Q. With costs so low, can the 401(k) business still be a profit center for Schwab?

A. We have a simple philosophy at Schwab – if we do right by clients, we will continue to grow.

That has been our experience for nearly 40 years and that is our objective here. As forSchwab’s economics, we’ve looked at this very carefully and are confident in our profitability.

Q. How does the new 401(k) effort fit into Schwab’s strategy of creating larger universe of investors who can be served more broadly by Investor Services, your retail business?

A. Certainly, being an advocate for participants and providing a high-quality experience engages them in a meaningful way. And we’ve seen that engagement results in a strong bond with participants who look to Schwab for their future financial needs. Today an important segment of retail client business first experienced Schwab as 401(k) plan participants and we have every reason to believe that trend will continue as we expand the pool of 401(k) participants we serve here.

That said, we are also studying ways that certain Registered Investment Advisors might be able to develop the professional, customized advice that will be delivered to the employees. If we are able to develop this capability, it will open the door, for the first time, for RIA’s to play a meaningful ongoing role delivering advice to the large end of the 401k marketplace. Stay tuned for more on what we are doing there.